When does debt consolidation make sense and how does it work?

What is debt consolidation?

Debt consolidation is the process of combining existing debts (like credit cards and personal loans) into one, in order to pay them off more efficiently.  This could involve taking out a debt consolidation personal loan, or using your home loan to cover your existing debts.

What are some benefits of debt consolidation?

Debt consolidation can have a number of potential upsides:

• You may get a lower interest rate and fees on your consolidated loan than what you’re currently paying.
• Your repayments may become more manageable with just one instead of several to keep track of.
• Unlike credit card debt, a debt consolidation loan is repaid over a set period of time, giving you a clearer structure and timeframe.

When should you be wary of debt consolidation?

Debt consolidation may not always be advisable if you are already having difficulty making your repayments. Other options could include deferring repayments or contacting your lender to ask for a hardship variation on your loan.

A creditor to whom you owe money may ask you to enter into a ‘debt agreement’ (such as a Part IX (9) debt agreement). It’s important to be aware that these debt agreements are still considered ‘acts of bankruptcy’, which can appear on your credit report for five years, making it much harder to borrow money.

If you apply for any credit or loan product, including a debt consolidation loan, this will also be noted on your credit report. If you make multiple applications for credit within a short space of time, this can make a negative impact on your credit score and affect your chances of getting approved for credit in the future.

Tip: Consider the total cost of consolidating

You’ll ideally want your debt consolidation loan to be more affordable than your existing debts. Compare the interest rate and fees of the new loan to those of your previous debts, plus the cost of exiting your current loans.

It’s also important to consider the new loan’s term length. Even if the interest rate is lower, a long loan term could mean that this option works out more expensive than if you’d paid your debts down separately.

When calculating the costs, don’t forget the fees you may need to pay to take out the new consolidated loan and to end your current loans. For example, if you break a fixed-rate loan, you will typically be charged a penalty or break fee for paying out the loan early.

Tip: Be careful of turning unsecured debt into secured debt

You may be able to get a lower interest rate by consolidating unsecured debt (such as credit cards and personal loans) into secured debt (such as a home loan). But this can be risky, as if you are unable to keep up with your new repayments, you could face your home being repossessed.

Also, while home loan interest rates are typically lower than those of personal loans or credit cards, home loans typically have much longer loan terms than other credit products—decades compared to years. This could cost you much more in interest payments, unless you choose to make extra repayments.

It’s also worth noting that the amount of debt you can add into a mortgage or similar secured loan may be limited by your usable equity. In the example case of a home, this is typically 80% of your property’s current value minus what you currently owe on your mortgage. If you haven’t been making extra repayments on your home loan, or if your property hasn’t increased in value since you purchased it, the lender may not let you add much more debt to the mortgage.

Where can you find help with debt?

In these cost-conscious times, you may be looking for ways to get your repayments down, but the decision to consolidate your debts should always be based on your financial situation and personal goals. Because every household is different, it may be worth speaking with a qualified accountant or financial advisor before making decisions.

That said, the fees for professional financial advice can be steep, meaning it may not always be a viable option if you are experiencing financial hardship.

If you’re struggling with debts and considering debt consolidation, you could consider talking to a financial counsellor first. It is free to speak to a financial counsellor and they are independent.

You can speak to a financial counsellor by calling the National Debt Helpline on 1800 007 007. The National Debt Helpline also offers a live chat, and you can send them a message online. If required, you can access an interpreter by calling the Translating and Interpreting Service (TIS) on 131 450 or call via the National Relay Service (NRS) too.